Markets @ Bidvest Bank - 07 July 2014

Fundamentals:

US:
• It was an early close on Thursday and markets were closed for trading on Friday all of which leaves us with little to report on this morning given the lack of significant data scheduled for release today.
• To recap, the payrolls data was strong reflecting an increase of 288K whilst unemployment fell to 6.1% and average hourly earnings rose 6 cents. All in all a good reading characterised by a drop in long-term unemployment all of which appears to be boosting demand for the USD which is currently trading at a 1 week high.
• Earnings season is fast approaching and investors will be hoping that the real economy data backs up the evidence in the economic data. There are some expectations of double digit growth in earnings.
UK:
• We still await the Halifax house price data that is scheduled for release either today or tomorrow. The data is expected to confirm that the trajectory of house prices for now is still upward albeit that upside momentum is slowing and likely to stall.
• Bear in mind that the next BoE rate decision is due this week Thursday, 10 July. No change is expected to policy which could render the event itself a non-event. The only real guidance will be provided by the minutes to follow where Carney will have to continue to justify the bank’s hawkish position against added criticism. The forthcoming minutes will thus be of interest as investors gauge the appetite for rate hikes.
Asia:
• At a quarterly branch manager meeting, BoJ Gov. Kuroda underlined the BoJ’s determination to stimulate the economy with QQE until such a time that 2.0% inflation can be sustained. Note that a report on the state of the regional economies are scheduled for release this morning and is expected to provide insight in the impact of the sales tax hike.
• Preliminary data shows Japan’s leading index fell for the fourth consecutive month and came in softer than expected in May at 105.7 vs. 106.5 in April. This marks the lowest level since January 2013 and affirms the broader risks to economic growth still entrenched. The coincident index similarly fell to 111.0 in May vs. 111.1 in April. Dovish overtures from the BoJ are expected to remain the order of the day as data remains mostly sluggish.
EU:
• Preliminary CPI data for the EZ was in focus today after last week’s initial German release posted a strong topside surprise. The ECB has been anticipating a bottoming of the downtrend in inflation with the help of a bump in energy prices, and should this unfold it could help to contain dovish expectations for the remainder of the year. The subdued cyclical environment in the Zone is ultimately still set to bias a broadly disinflationary environ for the foreseeable future, and the downside risks to growth and potential for deflation from this will keep the Bank’s dovish stance intact.
• In this regard the latest money and credit metrics also out today continue to reflect the trends of lending to the private sector still being in contraction while broad money growth is persisting at very subdued rates.

Developments worth noting:
• Since the firmer US payrolls report, US Treasury yields have been on the up and the curve has continued to adopt a gradual flattening bias. This is because of the link of jobs growth as an integral part of the Fed’s policy decisions and where not only continued QE tapering but now rate risk is now being more widely discussed in the markets. Goldman Sachs has brought forward its Fed hike forecast to Q3/2015 alongside a shift in forecasts made by other banks such as JPMorgan Chase and the broader market is now starting to reflect these sorts of rate pressures as the Dec 2015 Fed funds future rises to 0.80% from 0.67% a week ago.
• The turn in US rate expectations is significant purely because of how deeply accommodative the Fed has been seen to be in past years, and offers a strong contrast to what we are seeing in the likes of the EZ and China. The EZ is engaging in more monetary loosening while the PBOC continues to show signs of pumping liquidity into the financial markets in what has become a blurred line between fiscal and monetary policy in China. As a result we are seeing a divergence between the US and EZ/Chinese rate markets, with the US-German 10yr yield spread as one example now making 15yr highs just below 140bp. The upward pressure on US Treasury yields will ultimately force a similar re-pricing of risk across EM rates markets and this is expected to be reflected in foreign flows data as well as in a dollar that could prove more resilient going forward.
• More broadly for EMs it means that investors will be questioning where they park their funds more rigorously as the liquidity glut from the Fed slowly winds down. The US does face risk of a cyclical slowdown later into 2015 but for now the divergence in expectations between the US and the EZ and China is becoming more pronounced and this will impact on carry trades which have often in the past found a funding platform in dollars and yen. Local markets are particularly vulnerable in this respect as a number of factors contribute to the persistence of underlying rand fragilities, one being the still wide twin deficits while on the other hand the strike action continues to generate an erosion of confidence in the investment climate.
Data/Events for the next week:
• A quieter week of SA data this week but still one of importance as the May mining and manufacturing production data are seen on Thu. The market expects a deterioration in the y/y performance of the mining sector where the impact of the prior Amcu strike will still be felt for some time and where fairly soft aggregate demand continues to hamper the productive sector more broadly. The data will be of significance as the SARB policy meeting approaches towards the middle of this month.
• Following the busy US payrolls week last week, it is also a quieter week internationally with the biggest events being the Fed minutes on Wed and then the BoE rate decision on Thu. The Fed minutes may well serve to downplay the recent rise in rate expectations that has manifested into the stronger payrolls. The BoE is unlikely to make any major policy adjustments at this week’s meeting and the only guidance will be offered in the subsequent minutes.

Trade Weighted ZAR:

• As expected it was a quiet end to the week amidst the US public holiday and a retrenchment of trading volumes, leaving the USD-ZAR to consolidate in the mid 10.70s. The US markets have however met an important turning point as interest rate expectations start to gain serious upside traction, supported by the latest payrolls print. Out of these expectations we are seeing US Treasury yields start to climb more meaningfully again and the beneficial relative yield to be made out of the US has been a supporting factor to the dollar. Aside from the potential that beyond the short term there is the risk of these rate expectations rising too aggressively in context of a still cautious Fed, for now it appears that the dollar is set to gain some traction.
• We are starting to see this play a role in the trade-weighted performance of the rand, which is now down just under 1.0% for the month of July and 2.3% year-to-date. Its performance broken down on the week reveals that alongside the losses made against the USD, the rand is still struggling against the likes of the GBP and CNY as well as some of its emerging market peers such as the INR and BRL. This offers perspective on the nature of the trade-weighted deterioration in which the rand is still viewed as a less favourable EM currency based on its underlying risks. This sort of scrutiny has the tendency to emerge when global liquidity conditions are brought into question as they are now amidst talk of Fed rate hikes next year.
• Looking specifically at these underlying risks, the latest strike action from Numsa remains a risk to the growth outlook which not only serves to depress an already subdued interest rate outlook but also raises the potential for more negativity to come from the major ratings agencies. Furthermore, it threatens the viability of businesses in the productive sector and thus long-term capital investment. Foreign investors pricing in these risks are likely to be looking at the rand more cautiously and the potential for more underperformance is still expected.

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